Claremont McKenna College - Robert Day School of Economics and Finance

Date Written: August 2002

Abstract

This paper investigates the consequences of noisy evaluation of worker skills for skill investment and hiring. Individuals skew investment toward skills that most managers can best evaluate. In turn, this reinforces a tendency for managers to hire job applicants whose attributes they can best evaluate. In a dynamic context, where workers eventually become managers, managerial evaluation skills can become more and more skewed over time. Over the long haul, this has the effect of reducing both average employee productivity and the average quality of the job applicant pool. We distinguish two factors that affect a manager's ability to evaluate a particular skill: the manager's innate ability at that skill (nature), and his investment in the skill (nurture). We characterize how the dynamic evolution of the distributions of worker skill investments and worker productivity is affected by the relative importance of "nature" versus "nurture" for managerial skill evaluation. Surprisingly, investment distortions are it magnified if some firms either (a) compensate managers with equity, rather than a share of profit, in order to induce managers to internalize the future evaluation consequences of their hiring decisions, or (b) strategically select the managerial expertise of their personnel department; unless both (i) identifying whether a worker is skilled matters more than distinguishing among skilled workers, and (ii) the initial investment distortions are sufficiently small. Finally, we show that short-run affirmative action policies can be effective only if hiring more multi-skilled workers matters more than distinguishing among workers according to a single skill.